ATG:There are two main differences between now and 1929 that I can see. In our favor, we have the Federal Reserve's willingness to act as the lender of last resort and the taxpayers' willingness to bail out bank depositors. This will prevent a cascading series of bank collapses such as we had in the early 1930's, which caused massive corporate bankruptcies. Had there been these safeguards 65 years ago it is possible there would merely have been a bad recession, not a Great Depression.
On another point, however, our situation is much riskier than in 1929. This involves the difference between the nature of a recession and a depression; in short, the former is about liquidating excessive inventories, while the latter is about liquidating excessive companies.
I have argued earlier on this thread, and still see nothing to change this view, that there has been a wildly excessive amount of investment in new plant, equipment, and service capacity, relative to the underlying growth of demand, caused by excessive stock market valuations. People don't realize this yet, because the investment process creates demand as well as supply.
In other words, the first thing a technology start up company does is buy computers, networks and systems, but it pays for them with money given to it by investors and lenders, not money coming from operating cash flow. This adds to demand for products and sevices, but once up and running the new company is one more competitor in the high tech world. The impact of demand shows up first, supply later.
Should new investment slow down, as it would were there to be a significant bear market, the supply/demand imbalance would be a lot clearer, and show up in the form of collapsing profits as the new and old companies scramble for market share of a shrinking market. The booming stock market world wide has financed the existence of too many companies capable of surviving on the level of demand that would exist, were the market not booming.
Matters would be made worse by the very computerization and productivity improvements that is the heart of the bullish case. Technology and information have allowed companies to reduce headcount and substitute fixed costs (computers) for variable costs (people). That creates positive operating leverage when times are good, but when sales slow down, companies have lost the ability to shed variable costs to adapt. How can they cut costs - lay off the computers?
Moreover, companies with a fixed cost structure can and will cut selling prices drastically to hold onto market share, wiping out the profit margin for all competitors.
We have benefited many years from an upward spiral: rising profits-> rising stock prices-> optimism about future prospects-> more companies being financed-> companies spending their investment warchests-> strong demand-> rising profits, etc.
That spiral is fully capable of working in a downward direction as well.
The worst thing is that if that spiral turns down, it doesn't just produce a recession, which ends when excessive inventories are worked out of the system. It produces a depression and deflation, like the 1930's, which doesn't end until numerous companies and ventures have been liquidated and the underlying demand (perhaps aided by the productivity gains from computers) has risen enough to meet the lower level of supply. That could take years. |
